What is Economic Efficiency?

What is Economic Efficiency? It is the situation when the economy is using the scarce resources to produce the maximum outpu...




What is Economic Efficiency?




It is the situation when the economy is using the scarce resources to produce the maximum output in most effective way to fulfill the unlimited wants and desire of the people. In other words, the greatest possible levels of infinite wants are being met with those scarce resources. It gives the best possible solutions to the economic problems.  
       To achieve economic efficiency:-


  • Goods and Services must be made with the least possible cost.

  •          Those Goods and Services that lead to greatest possible satisfaction of our infinite wants are those that should be made.




    Types of Economic Efficiency

     
    1.    Productive Efficiency
     

    The situation in which the firms produce the products by using the least possible cost of 
    production or least scarce resources is known as productive efficiency.
               
         Under Productive Efficiency goods and services must be produced at the lower possible cost so, productive efficiency is said to be exist where production is made at the lowest point on a firms average cost (AC) .
                             

    Note:- Average Cost (AC) is define as the per unit cost of production of a firm.


    The concept of productive efficiency is illustrated by using the Average Cost(AC) curve.



    It costs C1 for a firm to produce a given goods operating at AC1’s lowest point. In comparison to AC1 and AC2 a firm cannot achieve economic efficiency since there would be higher cost by C1-C3. So, at higher cost lower quantity of goods will be produced. So there won’t be economic efficiency.

                   
         Hence, a firm operating at AC1 curve should organize it’s factors of production to produce goods at AC3 curve. A firm can  upgrade its machinery, increase financial incentives, etc to achieve AC3. A firm may not achieve economic efficiency in every point of AC1. It should operate at point “x”  where there is technical efficiency.

         
         The firm produces the product in a rational manner and feels difficult to produce at higher cost of production due to which the consumption can be decreased.

      
          The production efficiency can be further explained by using the Production Possibility Curve (PPC) which is shown below.


     
    Productive efficiency can also be shown through Production Possibility Curve (PPC). At point “Y” there is economic efficiency because it is operating at full employment level of resources. It is a maximum combination of resources that a economy can produce.

                     
           At a point “X” and economy is producing less quantity of consumer goods by Q2-Q1. So there is Productive inefficiency.

                   
           Productive efficiency can be further explained in the perfect competition market.




  • Above figure shows market condition In competitive market where P is a point in which MC=AC. Since, there is perfect competition. Rivals are much more aware of production cost. Every firm try to increase their sales by reducing cost.

                     
           Only those firms are able to survive in the market that is in productive efficiency. Productive inefficient firms cannot survive in perfect competitive market.

                  
          Hence, perfect competition guarantees productive efficiency. It is seen that perfect competition leads to the necessary conditions for Productive efficiency.



                              2.   Allocative Efficiency 

    It is the situation in the firm when the firm is producing the products which is more desired and can full the maximum wants of people. In other words it is a type of economic efficiency in which economy produces only that types of goods and services which are more desirable by the people in the market. It can be further explained by using the table and figure shown below.





    According to the definition, In above table 4 units of quantity can be produce when the price and the marginal cost is equal. So, to produce 4 units of quantity by using scarce resources is allocative efficiency.

                    It is more illustrated by following figure:-

     


          In the above figure the quantity is shown by x-axis and the price is shown in y-axis. It is the case of perfect competition. In the case Average Cost curve and Average Revenue/Marginal Cost line in which the producer produces the goods and services at lower possible point, AC curve in Perfect competition. Productive efficiency is not sufficient for economic efficiency. So, right amount of goods and services must be produced ( i.e Allocative Efficiency). As we know in allocative efficiency the price is equal to the marginal cost. So, in this figure:- in point “e” the price and marginal cost are equal so, it is known as point of allocative efficiency.
     
 

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